The Effect of Foreign Investment on Exports
In 1989, Mexico significantly liberalized its foreign investment regulations to allow
100 percent foreign ownership. The North American Free Trade Agreement of 1994
extends the areas of permissible foreign direct investment (FDI) and protects foreign
investors with a dispute settlement mechanism. In addition, Mexico has recently taken
a series of additional actions to increase FDI in Mexico. As a consequence, the US FDI
in Mexico has increased more rapidly in recent years than ever before. Mexico is now
the third-largest host country for US FDI after the United Kingdom and Canada.
Because FDI is generally used to set up foreign production, US exports to Mexico
should have dropped as a result of increased US FDI in Mexico. Right? Apparently
not, according to a 1999 study by Wilamoski and Tinkler. The study found that US
FDI in Mexico raises total US exports to Mexico and has a positive effect on the
US trade balance with Mexico. The removal of barriers to investment has allowed US
firms to establish a presence in Mexico. This has required the Mexican subsidiary to
import inputs from the US parent firms and capital goods from unaffiliated US firms.
International investment flows can boost efficiency and the flow of information
across borders. In addition, FDI is closely linked to export expansion. For example,
FDI by US companies can open the way for US exports, both as inputs to foreign production
and as consumer goods to supply foreign demand. It also offers US companies
a toehold in foreign markets, from which they can further expand sales. In many
cases, investment in distribution and other essential services increases a supplier’s
ability to export into a market. Trade between firms and their foreign affiliates
(intrafirm trade) can be an efficient means of international trade, particularly when
problems of imperfect information exist. Over a third of US exports and two-fifths of US imports are estimated to be intrafirm. Worldwide, about a third of trade is intrafirm
trade. In fact, many recent studies have confirmed that FDI is closely linked to export
expansion.
Human desires for goods and services are unlimited, yet our resources are limited. Thus, one of
our most important tasks is to seek new knowledge necessary to bridge the gap between desires
and resources. The traditional concept of economic man assumed that man allocates his scarce
resources between competing uses in the most economical manner. In Robinson Crusoe’s world,
for example, he would allocate his time for labor between different alternatives. He would use
one level site on the uncharted island as either the location for a hut (shelter) or as a vegetable
garden (food). Of course, the real world consists of many persons and nations that are interdependent
for sociological and economic reasons. Most societies face problems similar to those
faced by Robinson Crusoe, but in more complex forms.
The advantages of economic interdependence between persons and nations center mainly on
the efficiency of specialization. Specialization of function or division of labor allows each person
or nation to utilize any peculiar differences in skills and resources in the most economical manner.
There are a number of reasons why specialization produces a greater amount of goods and services:
1 Natural talents among people are different. If intelligent people specialized only in mental
tasks while physically strong people specialized only in physical tasks, the total amount of
their output would be greater than if each person tried to do both for him- or herself.
2 Even if the natural abilities of two persons are identical, specialization is advantageous because
it creates the opportunity for improved skills and techniques through repetition of tasks.
3 The simplification of function through specialization leads to mechanization and the use of
large-scale machinery.
4 Personal specialization saves time, because one person does not have to shift from one task
to another.
The theories of comparative advantage, factor endowments, and product life cycle have been suggested
as three major motives for foreign trade
The theory of comparative advantage
The classical economic theory of comparative advantage explains why countries exchange their
goods and services with each other. Here, the underlying assumption is that some countries can
produce some types of goods more efficiently than other countries. Hence, the theory of comparative
advantage assumes that all countries are better off if each specializes in the production
of those goods that it can produce more efficiently and buys those goods that other countries
produce more efficiently.
WHY COMPARATIVE ADVANTAGE OCCURS The theory of comparative advantage depends on
two elements:
1 Factors of production, such as land, labor, capital, and technology, are unequally distributed
among nations.
2 Efficient production of various goods and services requires combinations of different economic
resources and different technologies.
For instance, Canada has vast amounts of fertile land resources and relatively few people. In contrast,
Japan has little land and abundant skilled labor. Thus, Canada may produce such landintensive
goods as wheat more economically than Japan, while Japan may produce such
labor-intensive goods as cameras more economically than Canada.
However, it is important to recognize that the distribution of economic resources and technology
can change over time. This change may alter the relative efficiency of production. In the
past 10–20 years, some developing countries have considerably upgraded the quality of their
labor forces and have substantially expanded their stock of capital. Therefore, they now produce
capital-intensive products such as steel, machinery, and automobiles. Moreover, some newly
developed countries, such as Korea, Taiwan, and Brazil, now produce high-technology products,
such as computers and computer software.
In 1989, Mexico significantly liberalized its foreign investment regulations to allow
100 percent foreign ownership. The North American Free Trade Agreement of 1994
extends the areas of permissible foreign direct investment (FDI) and protects foreign
investors with a dispute settlement mechanism. In addition, Mexico has recently taken
a series of additional actions to increase FDI in Mexico. As a consequence, the US FDI
in Mexico has increased more rapidly in recent years than ever before. Mexico is now
the third-largest host country for US FDI after the United Kingdom and Canada.
Because FDI is generally used to set up foreign production, US exports to Mexico
should have dropped as a result of increased US FDI in Mexico. Right? Apparently
not, according to a 1999 study by Wilamoski and Tinkler. The study found that US
FDI in Mexico raises total US exports to Mexico and has a positive effect on the
US trade balance with Mexico. The removal of barriers to investment has allowed US
firms to establish a presence in Mexico. This has required the Mexican subsidiary to
import inputs from the US parent firms and capital goods from unaffiliated US firms.
International investment flows can boost efficiency and the flow of information
across borders. In addition, FDI is closely linked to export expansion. For example,
FDI by US companies can open the way for US exports, both as inputs to foreign production
and as consumer goods to supply foreign demand. It also offers US companies
a toehold in foreign markets, from which they can further expand sales. In many
cases, investment in distribution and other essential services increases a supplier’s
ability to export into a market. Trade between firms and their foreign affiliates
(intrafirm trade) can be an efficient means of international trade, particularly when
problems of imperfect information exist. Over a third of US exports and two-fifths of US imports are estimated to be intrafirm. Worldwide, about a third of trade is intrafirm
trade. In fact, many recent studies have confirmed that FDI is closely linked to export
expansion.
Human desires for goods and services are unlimited, yet our resources are limited. Thus, one of
our most important tasks is to seek new knowledge necessary to bridge the gap between desires
and resources. The traditional concept of economic man assumed that man allocates his scarce
resources between competing uses in the most economical manner. In Robinson Crusoe’s world,
for example, he would allocate his time for labor between different alternatives. He would use
one level site on the uncharted island as either the location for a hut (shelter) or as a vegetable
garden (food). Of course, the real world consists of many persons and nations that are interdependent
for sociological and economic reasons. Most societies face problems similar to those
faced by Robinson Crusoe, but in more complex forms.
The advantages of economic interdependence between persons and nations center mainly on
the efficiency of specialization. Specialization of function or division of labor allows each person
or nation to utilize any peculiar differences in skills and resources in the most economical manner.
There are a number of reasons why specialization produces a greater amount of goods and services:
1 Natural talents among people are different. If intelligent people specialized only in mental
tasks while physically strong people specialized only in physical tasks, the total amount of
their output would be greater than if each person tried to do both for him- or herself.
2 Even if the natural abilities of two persons are identical, specialization is advantageous because
it creates the opportunity for improved skills and techniques through repetition of tasks.
3 The simplification of function through specialization leads to mechanization and the use of
large-scale machinery.
4 Personal specialization saves time, because one person does not have to shift from one task
to another.
The theories of comparative advantage, factor endowments, and product life cycle have been suggested
as three major motives for foreign trade
The theory of comparative advantage
The classical economic theory of comparative advantage explains why countries exchange their
goods and services with each other. Here, the underlying assumption is that some countries can
produce some types of goods more efficiently than other countries. Hence, the theory of comparative
advantage assumes that all countries are better off if each specializes in the production
of those goods that it can produce more efficiently and buys those goods that other countries
produce more efficiently.
WHY COMPARATIVE ADVANTAGE OCCURS The theory of comparative advantage depends on
two elements:
1 Factors of production, such as land, labor, capital, and technology, are unequally distributed
among nations.
2 Efficient production of various goods and services requires combinations of different economic
resources and different technologies.
For instance, Canada has vast amounts of fertile land resources and relatively few people. In contrast,
Japan has little land and abundant skilled labor. Thus, Canada may produce such landintensive
goods as wheat more economically than Japan, while Japan may produce such
labor-intensive goods as cameras more economically than Canada.
However, it is important to recognize that the distribution of economic resources and technology
can change over time. This change may alter the relative efficiency of production. In the
past 10–20 years, some developing countries have considerably upgraded the quality of their
labor forces and have substantially expanded their stock of capital. Therefore, they now produce
capital-intensive products such as steel, machinery, and automobiles. Moreover, some newly
developed countries, such as Korea, Taiwan, and Brazil, now produce high-technology products,
such as computers and computer software.
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